U.S. business may know something about China they are not telling us. Despite booming Chinese growth, the U.S. share of foreign direct investment (FDI) in China has fallen from 11 to 3 percent since 2000. In absolute terms, U.S. FDI has fallen from $5 billion to its current $3 billion. If China is such a great place to do business, why are U.S. companies opting out?
More than 60 percent of China’s FDI now comes from Hong Kong and Taiwan. This is a form of “internal” FDI by insiders, who recycle money back into China or from outside-insiders who know the ins-and-outs of doing business in China. Russian FDI is similar: Most “foreign” investment comes from tiny Cyprus.
The decision of U.S. businesses to opt out of China, relatively speaking, is no surprise. China’s legal and economic institutions are those of a sub-Saharan African nation. China ranks directly below Guinea and Cameroon and just above Haiti in the world economic freedom index.
U.S. firms are not anxious to publicize their failures in China, but Yahoo had no choice. In its regulatory filing, Yahoo disclosed that Alibaba Group, 43 percent owned by Yahoo but under Chinese management, transferred Alibaba’s on-line payment service, Alipay, to a company headed by its Chinese CEO. Yahoo learned of the transfer only after it was completed and without approval of Alibaba’s board. Alibaba’s excuse: It had to transfer ownership because of regulatory rules.
In the wake of this disclosure, Yahoo’s share price fell 11 percent.
The Chinese CEO of Alibaba, Jack Ma, is a major businessman and celebrity in China. Presumably he is well connected. In a legal battle in China between him and Yahoo, Ma would be the winner.
Yahoo’s travails illustrate why China has such dismal institutional ratings. It is a good place to do business only as long as you stay on the right side of influential people. If they decide to take you to the cleaners, they can.
A few months back, a Taiwanese restaurant tycoon told me of his experience in Shanghai. After expressing an interest in opening a restaurant, city officials drove him around and asked him to identify some good locations already occupied by restaurants. He picked out a couple and was told that they could have the current owner out in a few weeks.
Another person with an intimate knowledge of Chinese business told me that experienced foreign firms no longer invest in China. Rather they let medium sized Chinese firms compete for contracts to produce specified goods without the bidders knowing their identity. The winning bidder delivers the goods, gets paid, and that is it.
Yahoo’s misadventure raises a serious question: Surely the highly-disciplined Chinese state and party know such arbitrary actions drive away foreign investment. They are bad for China. Would they not intervene on the side of Yahoo? The fact that they will not tells us that China is actually run by interest groups that look after themselves first. Only those who really know how to play the Chinese game will stay. But they are the ones with the least to offer China.
China’s rapid growth is explained by the vast transfer of technology from advanced countries like the United States and Germany. This transfer has taken place despite minimal protection of intellectual property rights. With China’s tightening labor market and wage inflation, China’s growth will increasingly depend on continued transfers of technology. If there are more Yahoos, this won’t take place.
Alibaba’s thieves are actually stealing from China, and there is no one to tell them to stop.